2. P A R T P A R T Partnerships 9 McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved. Introduction to Forms of Business and Formation of Partnerships Operation of Partnerships Dissolution & Winding Up Limited Liability Companies & Limited Partnerships

3. PARTNERS’ DISSOCIATION AND PARTNERSHIPS’ DISSOLUTION AND WINDING UP PA E TR HC 39 “Change is inevitable, but it is in us to control its content and directions.” Indira Ghandhi, Indian Prime Minister, speech (Jan. 8, 1967)

4. Learning Objectives  Dissociation  Dissolution and winding up the partnership business  When the business is continued  Partners joining an existing partnership 39 - 4

5.  Sometimes even the best-laid plans go awry and a business fails  Sometimes, it’s just time to make a change, modifying a partnership business to re- emerge as another partnership form, a Limited Liability Company, or a corporation  Whether an ending or new beginning, this chapter is about controlling a change in direction Overview 39 - 5

6.  The Revised Uniform Partnership Act (RUPA) defines dissociation as a change in the relation of partners caused by any partner ceasing to be associated in the carrying on of the business:  A partner’s retirement, death, or expulsion  A bankruptcy filing Dissociation 39 - 6

7.  Dissociation starts the process of dissolution, winding up (liquidation), and termination of a partnership  A partner has the power – but not necessarily the right – to dissociate from the partnership at any time, such as by withdrawing from the partnership  A partnership agreement may provide for a right of dissociation Dissociation 39 - 7

8.  Nonwrongful dissociation does not violate a partnership agreement and includes events such as the death of a partner and partner’s withdrawal in accordance with partnership agreement  Wrongful dissociation includes: 1. Withdrawal of a partner that breaches an express provision of partnership agreement Nonwrongful v. Wrongful 39 - 8

9. 2. Withdrawal of a partner before the end of the partnership’s term or completion of its undertaking  Unless partner withdraws within 90 days after another partner’s death, adjudicated incapacity, appointment of a custodian over his property, or wrongful dissociation Nonwrongful v. Wrongful 39 - 9

10. 3. A partner’s filing a bankruptcy petition or being a debtor in bankruptcy 4. Judicial expulsion of a partner by request of the partnership or another partner based on:  Partner’s wrongful conduct that adversely affects partnership business  Partner’s wilfull and persistent breach of fiduciary duties or the partnership agreement  Partner’s conduct makes it unreasonable to conduct partnership business with the partner Nonwrongful v. Wrongful 39 - 10

11.  Acts not causing dissociation include:  Partner’s transfer of transferable partnership interest  Creditor obtaining a charging order  Adding a partner  Disagreements between partners  Partners may limit or expand the definition of dissociation and events considered wrongful or nonwrongful Other Events & The Agreement 39 - 11

12.  When a partner dissociates, dissolution may be the next step, but RUPA allows the partnership business to continue after a partner’s dissociation  Thus dissolution is not automatic After Dissociation 39 - 12

13.  RUPA provides a list of events that force a partnership to be dissolved and wound up  List may be altered by agreement  In Horizon/CMS Healthcare Corp. v. Southern Oaks Health Care, Inc., the court considered grounds for dissolution contained in RUPA and a partnership agreement Dissolution 39 - 13

14.  Dissolution begins the winding up process:  Orderly liquidation of the partnership assets and the distribution of the proceeds to those having claims against the partnership  The implied authority of a winding up partner is the power to do those acts appropriate for winding up the partnership business Dissolution 39 - 14

15.  Winding up partners have apparent authority to conduct business as they did before dissolution  To eliminate apparent authority of winding up partner to conduct business in ordinary way, the partnership must ensure that one of the following occurs: 1. A third party knows or has reason to know the partnership has been dissolved Dissolution & Apparent Authority 39 - 15

16. 2. A third party received notification of dissolution by delivery of a communication to third party’s place of business 3. Dissolution has come to the attention of the third party 4. A partner filed a Statement of Dissolution with the secretary of state limiting the partners’ authority during winding up Dissolution & Apparent Authority 39 - 16

17.  Facts :  Partnership owned racehorse; a disagreement arose related to veterinary care and training  Two partners (plaintiffs) notified partner Crane they were dissolving the partnership and directed Crane to deliver horse to a trainer  Crane refused to relinquish control and plaintiffs sued, requesting court to appoint a receiver to continue racing the horse and then sell the horse; Crane objected Paciaroni v. Crane 39 - 17

18.  Legal Reasoning and Conclusion :  Once dissolution occurs, the partnership continues only to the extent necessary to complete transactions begun but not finished.  The partnership’s business purpose was to race the horse, thus “the winding up of the partnership affairs should include the right to race” the horse  The court also established some conditions. Paciaroni v. Crane 39 - 18

19.  After partnership assets have been sold during winding up, proceeds are distributed to those who have claims against the partnership  Includes partners, but creditor claims satisfied first Distribution of Assets 39 - 19

20.  Remaining proceeds from sale of assets will be distributed to the partners according to the net amounts in their capital accounts  Partner’s capital account is credited (increased) for capital contributions partner made to partnership plus partner’s share of profits  Partner’s capital account is charged (decreased) for partner’s share of partnership losses Distribution of Assets 39 - 20

21.  Asset distribution rules modified for a limited liability partnership since in an LLP most partners have no liability for partnership obligations  If a partner committed malpractice or another wrong for which LLP statutes do not provide liability protection, the partner must contribute funds to the partnership Distribution of Assets For an LLP 39 - 21

22.  After partnership assets have been distributed, termination of the partnership occurs automatically Termination 39 - 22

23.  Partners may choose not to seek dissolution and winding up after dissociation  When the business of a partnership is continued, creditors of the partnership continue as creditors of the person or partnership continuing the business.  Original partners remain liable for obligations incurred prior to dissociation  Including dissociated partners If Business Continued 39 - 23

24.  When partnership continues, partnership is required to purchase dissociated partner’s partnership interest  Partnership agreement may specify how to value the partnership or RUPA spells outs the amount and timing of the buyout of a dissociated partner’s interest  See Creel v. Lilly Buyout 39 - 24

25.  A partnership agreement generally states terms under which a new partner is admitted to a partnership  In absence of a partnership agreement, RUPA sets rules for partner’s admission and rights and duties upon admission:  New partner fully liable for all partnership obligations incurred after admission as partner, but no liability for obligations incurred before admission as partner Partners Joining Partnership 39 - 25

26.  RUPA states that a new partner in an LLP incurs no liability for any LLP obligations, whether incurred before or after admission, beyond new partner’s capital contribution unless new partner committed malpractice or other wrong (and incurs personal liability) Partners Joining LLP 39 - 26

27. Test Your Knowledge  True=A, False = B  Dissociation is the orderly liquidation of the partnership assets and the distribution of the proceeds to those having claims against the partnership.  When a partner dissociates, dissolution is the required next step.  Winding up is a change in the relation of partners caused by any partner ceasing to be associated in the carrying on of the business. 39 - 27

28. Test Your Knowledge  True=A, False = B  In winding up, remaining proceeds from the sale of assets will be distributed to the partners according to the net amounts in their capital accounts  Winding up partners have apparent authority to conduct business as they did before dissolution.  When a partnership continues, the partnership must purchase the dissociated partner’s partnership interest 39 - 28

29. Test Your Knowledge  Multiple Choice  James was a partner in a three-person law partnership without a partnership agreement. Medical bills forced James to file for personal bankruptcy. James has:  (a) Engaged in wrongful dissociation  (b) Engaged in nonwrongful dissociation  (c) Engaged in wrongful dissolution  (d) Engaged in nonwrongful dissolution 39 - 29

30. Test Your Knowledge  Multiple Choice  Greg, Pat, and Oprah were partners in a music store. Greg transferred his transferable partnership interest to his nephew. Greg:  (a) Engaged in wrongful dissociation  (b) Has exercised a partnership right  (c) Engaged in nonwrongful dissociation  (d) None of the above 39 - 30

31. Thought Questions  How would you deal with a partner who was mismanaging the firm or committed malpractice? How would you deal with a partner who had a substance abuse problem? 39 - 31